Stephen AND Patty K. PERSONAL INFORMATION AND BACKGROUND
Stephen and Patty K. want to plan for the life they will enjoy after they sell their business in the entertainment industry. The K. Family want to retire to a ranch, and they would like a financial planner to help them make their dream a reality. They do not have very much experience with investments and want help with setting up their portfolio and determining their future cash needs. They have eagerly collected data for your meetings.
Stephen K. is 54 years of age and Patty is 53. They were married 29 years ago and have three children. Stephen has worked as a publicist in the entertainment industry and started his own company 15 years ago. Patty has worked with him in the company for the past 10 years doing the bookkeeping and managing the finances of the company.
Name Relationship Age
Stephen Husband 54
Patty Wife 53
Anne Daughter 27
Kyle Son 24
Samantha Daughter 14
Plays the piano and does metalworking Paints and rock climbs
Coaches swim team and plays golf Pursues photography in his spare time
Plays soccer and gymnastics
Steven and Patty are in the process of selling their company for approximately $16 million ($14 million after taxes), but the terms and details of the sale are still not final. Steven thinks he will end up with an installment sale with the purchaser making a 20% down payment with the balance due in ten equal amounts annually plus 8% interest. They expect to complete the deal in the next two months. Steven will have to continue working for the company for at least 6 months to a year after the sale, and Patty will begin to make the arrangements for them to sell their house and buy a ranch in the West. Only Samantha will move with them, but Samantha is not happy about leaving her friends. Steven has promised her that she can have her own horse when they move. Samantha is still not sure that she will like the new life and has been throwing some fits lately. The other two children will not move to the ranch.
The K. family son Kyle has been living for a year with Susan Marshall, a woman he fell in love with on a rafting trip. She is 32 years of age and has a 4-year-old child. He has been asking about what he should do to provide for them in the event something happened to him. The K. Family would like a recommendation to help Kyle so he can do something to provide for them while keeping his options open for the future. Kyle has made no plans as yet to be married to Susan.
Stephen’s mother Jane, is 82, and lives in a large ranch style house in Florida. Her house is worth approximately $250,000. She has become less able to take care of her home and of herself and wants to move into an assisted living community. Jane has begun to show some signs of dementia, and Stephen would like to help her with her plans and is hoping she will find an assisted living community near his home. She receives Social Security checks, pension benefits, and income from investments set up by Steven’s father. The investments are worth over $300,000. In addition, Jane has a life insurance policy insuring her life with a face value of $150,000. Her other assets total approximately $150,000. The only estate planning that she has done was to have a will prepared ten yearsagothatleaveseverythingtoStevenandhisbrotherTedequally. StevenandTedarealsothebeneficiaries of her life insurance policy.
Patty’s mother, Carmen Inez, is 75 years of age and lives in Texas, a community property state. Carmen is a retired teacher. Patty would like to find a ranch for the K’s to buy near Carmen so Patty can help her
mother as she gets older. Carmen’s husband established a trust at his death two years ago to which he bequeathed investments worth $1 million. The value of the trust has declined to $800,000 currently. Under the trust, Carmen is to be paid all of the income annually, and she has a 5 & 5 power of invasion. Carmen has never exercised the 5 & 5 power and has been able to live off of the annual income with her other resources. The assets in the trust will pass to Patty when Carmen dies. If Patty is not alive, the assets pass to her children by representation.
GOALS AND OBJECTIVES:
1. Stephen and Patty want to sell the publicist business and their primary residence and use the proceeds to buy a ranch in the West.
2. After they sell the business, the K’s want to have income of $15,000 monthly.
3. The K’s want to provide for the education of their youngest daughter at a private college.
4. The K’s want to provide an inheritance for their children.
5. The K’s want to minimize their estate and gift taxes. Steven would like to make some substantial
gifts to his children to save on taxes, but after he sells his company, he will need a steady income from his assets.
Stephen and Patty have made the following assumptions for their financial planning:
Long-term inflation rate 3.0% Education inflation rate 6% Medical costs inflation rate 8% Current mortgage refinancing rates – 30-year loan 5% Current mortgage refinancing rates – 15-year loan 4.5% Maximum loan value on mortgages 80% Home equity line of credit rates 6.0% Treasury bill rate 1.0% CD rate (12 month) 1.25% Treasury note rate 2.75% Treasury bond rate 4.0% Corporate bond rate (AAA) 5.75% Average rate of return on S&P 500 Index 7%
ESTATE PLANNING INFORMATION
Stephen and Patty have simple wills in which they leave everything to each other.
Stephen and Patty live in a common law state. They have agreed to file elections for gift splitting for any gifts that they make.
INCOME TAX INFORMATION
Stephen and Patty had adjusted gross income of $285,000 last year and paid $62,000 in taxes to the federal government. They anticipate that their adjusted gross income this year will be about $315,000. They are in the 33% marginal federal tax bracket.
Stephen is anticipating that he will have a large tax liability when he sells his business and would like to make some charitable contributions to obtain some income tax deductions to reduce his tax liability. He would like to make a gift that will benefit an animal shelter where his daughter volunteers. He would like the gift to benefit the shelter immediately. Stephen is considering a substantial gift but is concerned also about the reduction in his children’s inheritance from a large gift.
After the K’s. sell their business, they will retire from the entertainment industry and plan to raise some horses. Stephen and Patty project that they will live 35 years in retirement. They also assume that inflation will average 3.0% both before and after retirement, and their investments during retirement will earn a 5.5% rate of return.
The K’s have a profit sharing plan at work and they are fully vested in the plan. They have IRAs to which they contributed for many years before the company set up the profit sharing plan.
Stephen and Patty have contributed $30,000 to a 529 plan for Samantha. The money is invested in a bond fund, and the value is now $35,000. They assume that the current annual cost of an education at a private college is approximately $38,000, and it will increase 6% per year. They also want to fund an additional two years of graduate school in case Samantha decides to get a masters degree.
Stephen and Patty have a brokerage account that is currently worth $57,000. The account is invested in bonds as shown below.
U.S. Treasuries Municipal Bonds Corporate bonds (AAA)
(End of Last Year)
$10,000 $12,000 $25,000 $28,000 $14,000 $17,000
Stephen and Patty consider themselves moderate-risk investors. They want to be sure that they will have adequate income for their retirement and want help with investing the proceeds of the sale of the business to maintain their lifestyle. They do not want to lose their investment by taking unnecessary risk.
Stephen’s salary Patty’s salary Investment income
Stephen and Patty K. Projected Cash Flow For the Current Year
$ 77,000 $170,000 $ 14,000 $ 39,000 $ 15,000
Taxes (income, payroll, real estate) Lifestyle expenses
Cash and Cash Equivalents Checking account: JT
$ 26,000 65,000 110,000 54,000 33,000 288,000
Savings account: JT
Life insurance cash value: H Life insurance cash value: W
Total Cash and Cash Equivalents
Profit sharing plan: H 1
Profit sharing plan: W 2 IRA: H 3
IRA: W 4
Variable annuity: H 5 SK Media Company: H 6 Brokerage account: JT 7 529 Plan: H
Total Invested Assets
Personal-Use Assets Home: JT 8
Vacation house: JT 9 Jewelry: W Mercedes: H 10 SUV: W
Furniture and household items: JT TotalPersonal-UseAssets
LIABILITIES AND NET WORTH
Mortgage - home: JT 11
Mortgage - vacation: JT 12 Credit card debt 13
Car loan 14
212,000 97,000 142,000 111,000 125,000 16,000,000 57,000 35,000 16,779,000
Total Liabilities Net Worth
210,000 125,000 3,000 19,000 357,000
Statement of Financial Position Stephen and Patty Kirchner As of December 31st Last Year
$ 350,000 190,000 31,000 35,000 32,000 90,000 $ 728,000
$ $ $ $ $
Notes to the Financial Statements
H = Husband
W = Wife
JT = Joint tenancy
1 Patty is the primary beneficiary, and their children are the contingent beneficiaries.
2 Stephen is the primary beneficiary and their children are the contingent beneficiaries.
3 Patty is the primary beneficiary. Stephen was able to deduct all of his contributions.
4 Patty’s parents are the primary beneficiaries. Phyllis was able to deduct all of her contributions.
5 Stephen purchased the annuity a few months ago for $125,000. It’s invested in a balanced fund subaccount. Stephen named Patty as the primary beneficiary and their children as the contingent beneficiaries.
6 SK Media is a C corporation; the value is from a recent appraisal; Stephen basis is $1,600,000.
7 All funds in brokerage account contributed by Stephen. See Brokerage Information for account detail.
8 The land is worth $100,000. Their current basis is $250,000.
9 The land is worth $50,000. Their current basis is $175,000.
10 The Mercedes was purchased new for $45,000.
11 There are 16 years remaining on the mortgage. The interest is fixed at 6.0%.
12 There are 25 years remaining on the mortgage. The interest is fixed at 7.5%.
13 The credit card carries a 9% interest rate for the next 24 months.
14 The Mercedes car loan has a 4% interest rate and will be paid off in 3 years.
Insured Owner Beneficiary Face Type Cash Annual Notes Amount Value** Premium
Patty, and the children
are contingent beneficiaries
Bought 14 years ago; loan* taken for $10,000
Stephen, and the children
are contingent beneficiaries
Bought 10 years ago
*Stephen’s loan accrues interest at 6% annually. He has not made any payments of interest.
**Patty’s cash value earned 5.5% last year and in the current year will earn 5%. Stephen’s cash value will earn 3%.
Current Benefit Amount
To age 65 2 years
3% per year
Premium paid by Stephen
Premium paid by Patty
*Stephen disability income policy is guaranteed renewable and has a split definition of disability, a 60-day elimination period, and a cost-of-living adjustment rider.
Stephen and Patty
HO-3 (Home) HO-2 (Vacation house)
$500 per person
$5,000 (includes deductible)
Paid by employer
Dwelling Amount $250,000
Contents Coverage $190,000 ACV $100,000 ACV
Personal auto policy
Personal auto policy
Collision Comprehensive (other-than-
$500 $500 deductible deductible
$500 $500 deductible deductible
1. The first issue to determine is: Do the K’s reside in a Common Law or Community Property Jurisdiction? Per the Case Facts, Patty and Stephen reside in a Common Law Jurisdiction. This makes their individual assets “fee simple” or sole ownership probate property, jointly-held assets as “qualified joint interest” non-probate property, and assets with beneficiary designations (life insurance, variable annuity, IRAs and Profit Sharing Plans) non-probate property that pass under operation of law to the primary beneficiary, if living.
2. As such, Stephen’s Probate Estate consists of Treasury Bills, the SK Media Company, and his Mercedes auto, for a total Probate Estate of $16,145,000. Stephen’s non-probate
estate includes one-half of jointly-owned property, his life insurance policy, and his
retirement accounts (total $1,118,000) bringing his Total Gross Estate to $17,263,000.
3. Patty’s Probate Estate consists of her jewelry and her SUV, bringing her total Probate Estate to $63,000. Her non-probate estate consists of one-half of the jointly-held
property, and her life insurance policy, IRA and Profit Sharing Plan, bringing her Total
Gross Estate to $810,000.
4. In terms of asset valuation, all assets are included at their fair market values, with the exception of the 529 Plan established and owned by Stephen. 529 Plan assets are
excluded (an exception to the general rule) from an account owner’s gross estate unless
the account was “front-loaded” with 5 years’ worth of annual exclusion contributions in
one calendar year, and the owner died at some point during the 5 year period. The amount that is included in the estate under this scenario is the “unexpired” portion of remaining annual exclusions. Life insurance policies are included at their full, face value where the owner is also the insured. If the owner is not the insured, the policy is included at its interpolated terminal reserve value (policy cash value plus unused portion of the annual premium). Policy loans are classified as “debts of the decedent” and are deducted from the Gross Estate on Schedule K of Form 706, not from the policy
face value. Where the insured irrevocably relinquished ownership of the life insurance policy within 3 years of death, the policy is included at its full, face value as a “transfer in contemplation of death.”
5. Some of you included the mortgages, car loan, and credit card debts as reductions to the gross estate values of the assets. Again, debts do not reduce the gross estate value
of the assets, but rather are debts of the decedent and are used to arrive at the
Adjusted Gross Estate (Gross Estate less debts, funeral and administration expenses). Secured debts (mortgages, life insurance policy loan and car loan) follow the rules of
2 ownership of the assets that are collateralized by the debt. So, the two mortgages are considered qualified joint debts, and are deductible to the extent of one-half the outstanding balance as of date of death. The Mercedes car loan is attributable to Stephen
as sole owner of the car, and the life insurance policy loan is also attributable to
Stephen’s life policy. The only debt that was not collateralized, and not attributed to one spouse or the other was the credit card outstanding balance. Since we were not given specific information on the credit card account, you could have attributed it in full to
either Stephen or Patty, or considered the debt as being an equal obligation of each
6. In general, while it may seem that I am being extremely “precise” in the categorization of assets and liabilities, the CFP® Board will expect such precision on the Certification Examination. The K Case is representative of Case Analysis questions on the CFP® Certification Exam (worth the most points), where candidates are presented with a full
case of information, but the questions asked may pertain to only one or two financial planning topics. It will be up to each candidate to parse the information provided and to determine what is and isn’t relevant to the questions being asked.
The Final Part of the Kirchner Case will be due at the end of Week 8, and will consist of your
recommendations for the Kirchners on how to strengthen their existing estate plans, based on their stated objectives given in the case facts and my questions. You may wish to begin giving some thought to the final submission now, given what you have learned up to this point in the course.
Using the asset information distributed in my email earlier this week, please update your respective Excel Spreadsheets, and then: (ABOVE)
(1) Compute the Adjusted Gross Estate for each of Patty and Stephen assuming each is the first to die
(2) Identify the assets that will pass via the marital deduction assuming: (a) Stephen predeceases Patty, and
(b) Patty predeceases Stephen.
(3) Total these amounts for each estate.
(4) Assume the K’s decide to fund a Charitable Lead Annuity Trust for the benefit of the Animal Shelter, a 501(c)(3) organization this month (September, 2018). The CLAT will payout 5% annually for 10 years, giving them a Remainder Value equal to 58.2% of the value of the property placed in the CLAT.
(a) How much would you recommend the K’s contribute to a CLAT?
(b) Which asset(s) would you recommend they use to fund the CLAT? Why?
(c) Will the K’s receive an estate tax charitable deduction for the creation of the CLAT when they die, if they die within the next 10 years?
(5) Compute the Tentative Taxable Estate for each of Patty and Stephen, assuming each is the first to die.
Upload your spreadsheets